AFL

AFLAC INC 10-Q Summary: Quarter Ended March 31, 2004

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2004, for AFLAC Incorporated and subsidiaries. The company primarily sells supplemental health and life insurance in the United States and Japan. Operations are divided into two reportable segments: AFLAC Japan and AFLAC U.S. The financial statements are unaudited but have been reviewed by independent auditors (KPMG LLP).

Key Financial Metrics

Margins and Ratios: The combined U.S. and Japanese effective income tax rate on operating earnings was 35.1% for Q1 2004. The debt-to-total capitalization ratio was 24.0% as of March 31, 2004.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 16.9% year-over-year, driven by an 18.0% increase in AFLAC Japan premiums and a 13.9% increase in AFLAC U.S. premiums.
• Earnings Growth: Net earnings rose 32.9% to $315 million. Pretax operating earnings increased 20.7% to $455 million.
• Foreign Currency Impact: The yen strengthened against the dollar (average rate 107.32 in 2004 vs. 118.93 in 2003). This translation effect increased reported operating earnings by $15 million in 2004 compared to $13 million in 2003.
• Investment Portfolio: Total investments and cash grew to $46.4 billion. The yield on AFLAC Japan's portfolio was 4.44% at March 31, 2004, down from 4.71% a year prior, reflecting lower market yields.
• Dividends: Cash dividends per share increased 36% to $0.095 from $0.07 in the prior year.

Guidance, Outlook, and Risks

Guidance: Management's objective for 2004 is to achieve net earnings per diluted share of at least $2.21, representing a 17% increase over 2003. This projection assumes no realized investment gains/losses, no change in the fair value of cross-currency swaps, and no nonrecurring items. The outlook is sensitive to the yen/dollar exchange rate; a weaker yen would reduce reported EPS.

Management Commentary:

• AFLAC Japan: Sales of the stand-alone medical policy "EVER" remain strong, now exceeding sales of "Rider MAX." The benefit ratio is expected to continue declining due to product mix shifts.
• AFLAC U.S.: Sales growth is being supported by expanded sales management infrastructure and new training programs. The objective is 10-12% sales growth for 2004.
• Nonrecurring Items: A one-time gain of $6 million (after-tax $3 million) was recognized from the transfer of certain pension obligations to the Japanese government.

Risks and Contingencies:

• Market Risk: Significant exposure to foreign currency fluctuations (yen/dollar) and interest rate changes. A 100 basis point increase in interest rates could reduce the fair value of debt securities by approximately $4.3 billion.
• Credit Risk: The company holds $1.17 billion in below-investment-grade securities (amortized cost), primarily due to rating downgrades of specific issuers (e.g., Ahold Finance, KLM). Management believes these declines are temporary and not credit-related impairments.
• Regulatory: Subject to regulatory restrictions on dividends and capital transfers from insurance subsidiaries in both the U.S. and Japan.

Investor Verification Checklist

• Foreign Currency Sensitivity: Verify the impact of the yen/dollar exchange rate on reported earnings, as management excludes this from internal performance evaluation.
• Investment Yield Trends: Monitor the declining yield on new investments in Japan (2.51% average yield in Q1 2004) and its effect on future profit margins.
• Below-Investment-Grade Holdings: Review the $1.17 billion portfolio of below-investment-grade securities and management's assessment of "other-than-temporary" impairments.
• Share Repurchases: Confirm the status of the $127 million treasury stock purchase program and the remaining 34 million shares authorized for repurchase.
• 2004 EPS Target: Assess the feasibility of the $2.21 diluted EPS target given the assumptions regarding currency translation and investment gains/losses.